Warren Buffet talks about Pension Actuaries

[Old Actuary]

The following excerpt is from Motley Fool at
http://www.fool.com/news/foth/2001/foth011127.htm

>>Buffett then proceeds to blast the actuaries: "The actuaries who have roles in this game know nothing special about future investment returns. What they do know, however, is that their clients desire rates that are high. And a happy client is a continuing client."<<

Buffet is upset that pension actuaries are setting or agreeing to investment return assumptions that are too high. The author characterizes the statement as "effectively calling actuaries corrupt." Pretty strong words.

[WWSituation]

Have Buffett and Andy been talking together??

[Senor]

How often are valn rates higher than 7% (the figure he expects returns to be near)?

[Laocoön]

On 2001-11-29 19:43, Senor wrote:
How often are valn rates higher than 7% (the figure he expects returns to be near)?


Almost always. This is the expected return on investments rate, remember, so those with lots of equities tend to think they're being conservative with 9% -- the long-term average annual return on equities is around 11%, after all.

I believe there was a footless stranger here once who criticized the same thing, but for a different reason.

[Mr. Grim]

i think he has hit a good point - the FASB accounting figures leave alot of room for manipulation and most CFA types who analyze these do not understand the impact of a change in the assumptions can have on the figures.

[Dr J Fan]

He's probably out fighting evil. He should check out the riff-raff that those CASt-offs are hobnobbing with.

I think the CFAs know what the assumptions do to the figures. The problem is that they don't think about the possible consequences. Also known as financial risk.

[aNoNo]

The FASB pension numbers really belong to the Company management as approved by the Company's CPA firm. The actuaries basically just "turn the crank" to spit out the FASB pension numbers based on the assumptions from the Company's management.

Of course, it is a different story for the ERISA/IRS funding/tax pension results. Here the Enrolled Actuary is affirming his/her stamp of approval on the actuarial assumptions used for the cash pension valuation (as opposed to the FASB GAAP pension valuation).

Going back to the FASB pension numbers, it is a pretty simple excercise to adjust the FASB expected return on plan assets if you do not like the long-term expected rate of return assumption used in the Company's pension footnote. There is kind of a dis-connect in FAS 87 that a current interest rate is used to value the ABO/PBO liabilities but the expected rate of return on plan assets is from a long-term perspective. The controversy is that the "long-term perspective" is pretty much in the eye of the beholder. This is probably an area where Board Audit Committees should be involved, but the "Board of Buddies" system does not really encourage diligence.

Pension accounting is really not a mystery anymore. There have been several articles in the WSJ about the impact of FASB pension accounting on Company's reported GAAP earnings.

Buffet is obviously savvy enough to know that the management of some Companies are quite good at cooking the books from time to time.

I wonder if Buffer had much exposure to Enron?

[Mr. Grim]

I would argue that pension income should not be allowed to impact the bottom line as it is not even company money, per-se. A minimum pension expense of 0 should be implemented.

[Laffit Pincay, Jr.]

While the pension funds are not available for use by the company there is a catch:

If a plan is underfunded the company has an unfunded liability creating a FAS 87 expense that hits the books, so when the plan is overfunded they have a credit which symmetrically hits the books.

I'm not saying this is good or bad but it is what the accountants wanted.


<font size=-1>[ This Message was edited by: Laffit Pincay, Jr. on 2001-11-30 16:43 ]</font>

[Andy Lang]

Ill comment on some of the points you guys are making later on..but here is message from one of the leaders of the IBM dissidents, who it should be noted are leading a revolution out there in the big wide real world, http://clubs.yahoo.com/clubs/ibmpension), http://clubs.yahoo.com/clubs/andylang --the one they set up for me to do my thing, and http://www.cashpensions.com) (points BTW for anyone what the name Har Philby is all about, and why he says he is from Moscow)...

"Folks,

Since the churches aren't open yet in Moscow, I thought I'd treat you with a tidbit I read a few minutes ago:
-----------------------
From the Motley Fool.com:
http://www.fool.com/news/foth/2001/foth011127.htm
-----------------
The scandal of pension fund accounting
Buffett saves his strongest language for the topic of pension fund accounting. (You can read my rant on this topic in last week's column. The long-running bull market, in short, inflated the value of the funds many companies had set aside to pay future pension obligations, such that the plans became overfunded. This, in turn, allowed companies to apply such gains toward reducing product or operating costs, thereby inflating earnings.)

Buffett uses similar statistics to those I presented, but adds a powerful twist: He compares the expected pension fund returns certain representative companies are using today with the expected returns the same companies used in 1975 and 1982.

Despite far lower interest rates today (a significant fraction of pension funds are invested in bonds), these companies are projecting far higher returns, which Buffett thinks are ludicrous: "I'm a sporting type, and I would love to make a large bet with the chief financial officer of any one of [ExxonMobil (NYSE: XOM), GE (NYSE: GE), General Motors (NYSE: GM), and IBM (NYSE: IBM)], or with their actuaries or auditors, that over the next 15 years they will not average the rates they've postulated."
So why are the assumptions so high? To some extent, Buffett notes, it's "that rear-view mirror again," but he also notes that "heroic assumptions do wonders... for the bottom line. By embracing those expectation rates... these companies report much higher earnings -- much higher -- than if they were using lower rates."

Buffett then proceeds to blast the actuaries: "The actuaries who have roles in this game know nothing special about future investment returns. What they do know, however, is that their clients desire rates that are high. And a happy client is a continuing client."

After effectively calling actuaries corrupt, Buffett then targets companies and their boards of directors:

"Unfortunately, the subject of pension assumptions, critically important though it is, almost never comes up in corporate board meetings. (I myself have been on 19 boards, and I've never heard a serious discussion of this subject.) And now, of course, the need for discussion is paramount because these assumptions that are being made, with all eyes looking backward at the glories of the 1990s, are so extreme."

"Considering how poor returns have been recently and the reprises that probably lie ahead," he continues, "I think that anyone choosing not to lower assumptions -- CEOs, auditors, and actuaries all -- is risking litigation for misleading investors. And directors who don't question the optimism thus displayed simply won't be doing their job."

Wow! Buffett does not lightly use words and phrases like "critically important," "extreme," "litigation for misleading investors," and "won't be doing their job." In fact, having read a great deal of what Warren Buffett has written for public consumption over his career, I can safely say that I can't recall any instance of him using such strong language, even for other corporate evils about which he feels strongly.

-- Whitney Tilson

***

Hare is slighty behind, I posted message 43694, but the full text of Buffet's is welcome anyway.

One more note--every word and every message in these forums and the website are being burned into CDs so as not to allow a Lobersterman, let's say, destroy them...

Talibaners are not the only ones who need to switch sides, before the massive bombing destroys them...

Don't feel too bad, GW Bush is doing so all the time these days, even his daddy, and he is is likely to leave behind nice political advisors, like Karl Rove to mention just one.

Just like the Afghan switch-hitters, we will have to watch carefully to see if it is permanent or not.